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Friday, May 11, 2012

The Smell of Morgan in the Morning

JPM CEO Jamie Dimon has had better days.

This is more than a wee hiccup. MainePERS portfolio managers are hurling big time following the disclosure later yesterday afternoon that JP Morgan Chase (ticker symbol: JPM) will be taking investment losses in the second quarter. How big will those losses be? The answer (and all you PMs out there, take your ulcer meds first): no one knows.

JPM is a Top Ten holding in the MainePERS equity portfolio. Or was. At the end of the first quarter, MainePERS held 959,294 shares of JPM common stock with a market value of over $44 million. At that time the shares were priced at about $46 a share. In pre-market trading this morning, shares are going for around $38. So in the last six weeks, MainePERS has lost $7.67 million on JPM alone. The ripple effect on the shares of other Wall Street banks (remember, MainePERS owns 2.5 million shares of Bank of America) compounds the damage.

JP Morgan Chase hastily arranged a conference call with industry analysts at 5 p.m. yesterday, a whiff of panic in the air. The call coincided with the release of the company's latest 10-Q filing with the SEC. Scroll down to Page 9 and you will see what the commotion is about:

Since March 31, 2012, CIO [Chief Investment Office] has had significant mark-to-market losses in its synthetic credit portfolio, and this portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the Firm previously believed.

How volatile, you ask? Is $2 billion vaporized in just six weeks volatile enough for you? Now, some of that loss has been offset by gains realized through the sale of other securities. Halfway through the quarter, the net loss for the Corporate unit within the Corporate/Private Equity segment for the whole quarter ending June 30 is estimated at $800 million. The firm's prior guidance had been for a gain of $200 million. So that's a billion-dollar swing.

The firm's polished CEO, Jamie Dimon [above], did not hide his displeasure during the conference call. Actually, one wonders why he held the call in the first place. The 10-Q had been filed and the disclosure made. The projected loss for Corporate, at first glance, does not appear to be that big of a deal for a firm as big as JPM, which books quarterly profits in the neighborhood of $5 billion. In the first quarter Corporate showed a loss of $697 million. That was amply covered many times over by the rest of the company. So why panic now?

Here's why. Those synthetic credits are still on the books and may be marked down further. [Update, 05-17-12: take off another billion. And two more. And two more after that.] The position is simply too large for the company to disgorge all at once without driving prices down to fire-sale levels. And now that JPM's hand is exposed, competitors will get in front of the unwind, making the exit even more expensive. (Bloomberg has the story here.) The 10-Q says it all:

The Firm is currently repositioning CIO's synthetic credit portfolio, which it is doing in conjunction with its assessment of the Firm's overall credit exposure. As this repositioning is being effected in a manner designed to maximize economic value, CIO may hold certain of its current synthetic credit positions for the longer term.

In other words, Jamie may be stuck in his position, kind of like the Hotel California. You can check in any time you like, but you can never leave.

Does that make MainePERS stuck as well?

[P.S.--Financial geeks may be interested in this suggestion at ZeroHedge that JPM may be looking at another $3 billion in downside related to the CIO's hedging activities. "Oh the fun of negative convexity--especially when you ARE the market and there is no one to unwind the actual tranches to."]

[P.P.S.--"I told you so!" Janet Tavakoli saw this coming two years ago when she warned about "delusional risk-taking and lack of transparency at Too-Big-To-Fail banks," where "ambitious managers strive to pump speculative earnings from zero to hero." HuffPo has the update here.]

[Lastly, Dr. John Hussman observes: "Maybe the right question isn't why they lost money on the hedging transaction, but why they apparently have a boatload of questionable assets so massive that they need to use whale-sized leverage to hedge the default risk in the first place."]